Done Wrong, Groupon Can Cost Business Big

CHICAGO (TheStreet) -- Think of it as the 21st century version of clipping coupons. Groupon, a website that sets up discount shopping deals, has boomed in these penny-pinching times. In only two years, it has expanded to 90 U.S. cities and gathered 13 million subscribers.

For the most part, Groupon's deals feature small businesses, from restaurants and spas to specialty stores and dance schools. There's no question it's a hit with customers, who get to try out a product or service for half or more off the regular price. Because a deal can be activated only if a certain number of people sign up, shoppers are encouraged to forward the offer to friends and family -- increasing Groupon's reach.

Groupon definitely pays off for bargain hunters. But is it a good deal for businesses? In many cases, yes. Groupon says its own surveys show 95% of its business partners would sign up again. For new, not-yet-established businesses, it's an easy way to get exposure to a huge network of potential customers.

But a recent independent study found there are potential downsides as well. Utpal Dholakia, associate professor of marketing at Rice University's Jesse H. Jones Graduate School of Business, surveyed 150 businesses that had signed up with Groupon in 19 different cities. About 40% said they would not do it again.

"The businesses seemed to fall into two camps," he says. "Some were absolutely thrilled with the success of their promotion. Others had a terrible experience." Groupon promotions were profitable for about two-thirds of respondents -- one-third actually lost money on their deal.

So what makes for a successful social-promotion effort? "For the most part, it comes down to expectations and preparation," Dholakia says. Owners who lay the groundwork for a rush of customers do well, while those who don't prepare their employees adequately can face a backlash.

Dholakia decided to study the Groupon phenomenon after a disappointing experience with a restaurant he visited regularly in Houston. While getting a table there was usually no problem, he was surprised to find an hour wait one night; he soon learned the restaurant had been featured on Groupon, bringing in a flood of first-time diners.

"The service was terrible, the waitstaff looked unhappy and they were out of the specials," Dholakia says. The experience left him wondering how many other full-paying regulars were being turned off by the crowd of bargain-hunters.

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